KRUGMAN: 'Cyprus Should Leave The Euro. Now'

Krugman says he's been challenged by someone he respects to take a position on the issue.

Thus, he writes:

So here it is: yes, Cyprus should leave the euro. Now.

The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.

If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP.

Krugman's argument is similar to that made by Moody's on Sunday night, when the credit rating agency said Cyprus was still at risk of defaulting on its public debt and leaving the common currency.

The chart below from Moody's shows just how integral to Cypriot economic growth the banking sector there has become.

Eurostat, Moody's calculations

Krugman points out that since capital controls are already in place in Cyprus – as the country braces to re-open its banks and commence a run on deposits – there's not much left to lose on that front.

"So if I were dictator, I’d just extend the bank holiday long enough to prepare for the new currency," says Krugman.